Tokyo's tax year has come to a close, but the 2020-2021 tax year got off to an all-too-familiar start: a selloff.

The Topix index of the broad Tokyo market fell 3.7% on Wednesday, one of the worst showings in Asia on a down day for markets. That decline follows a quarter in which Japanese equities dropped 17.8%.

Investors are particularly concerned that Japan is about to roll out stricter measures to combat the Covid-19 virus than it has so far. Volume in Tokyo was low as investors tried to translate a mixed message from the government.

Chief Cabinet Secretary Yoshihide Suga told reporters that Japan is on the brink of declaring a state of emergency, although it has yet to do so. The number of infections in Japan has sped up in recent days.

So far, Japan has resisted shuttering businesses, and even bars and nightclubs remain open. Its early efforts to track the contacts of confirmed cases, together with voluntary measures by the public to wear masks and avoid unnecessary contact, has kept the outbreak manageable so far. There are "only" 2,259 cases and 66 deaths among a total population of 126 million.

Tokyo remains the world's largest conurbation, however, with 13.9 million people in the city proper and 37.4 million, or almost one-third of the nation, living in the metro area. There were 65 new cases reported in the capital on Wednesday after a record 78 the day before, bringing the total there to around 500. Only 10 days ago, the entire nation had fewer than 1,000 cases, so it appears to be experiencing a second and higher peak of new infections.

The tankan survey of business sentiment released by the Bank of Japan on Wednesday showed that the corporate climate has deteriorated significantly. Manufacturing sentiment produced the first negative reading, of -8, since the first quarter of 2013. That was at the very onset of Prime Minister Shinzo Abe's program of "Abenomics" designed to reflate the Japanese economy after two aimless decades.

Negative business outlook

A negative reading shows that pessimists who expect business conditions to get worse outweigh the number of optimists who predict it will get better. Non-manufacturing executives were not quite as gloomy, with a reading of +8, but that was down from +20 in December and also the worst reading in seven years. Both manufacturers and executives in other industries have a pessimistic, negative forecast for next quarter.

The government is due to introduce a stimulus package next week. That will demonstrate to what extent the world's third-largest economy is willing to back extremely loose monetary policy that has driven interest rates below zero with direct stimulus and government spending. Abe promised on Saturday that the package would be bigger than after the 2008 financial crisis, which back then was ¥57 trillion (US$528 billion), and will incorporate "huge, powerful" measures.

The budget will need to be at least 2% of GDP, and solid, "in order to ease the anxiety of households and businesses, and prevent demand from collapsing," Société Générale economists Takuji Aida and Arata Oto said in their tankan analysis.

Should corporate and consumer sentiment continue to take a turn for the worse, it could waste the progress made under Abe, who has made significant strides in restoring confidence and optimism about the economy.

Japan Inc. had finally broken its cycle of intense savings, which has left many Japanese corporations with huge but inefficient piles of cash. Capital expenditures had broken 16% in relation to GDP, finally climbing to new highs since the bursting of Japan's bubble in the late 1980s. Prior to that, the hoarding of savings by Japanese companies had been destroying domestic demand, causing a deflationary spiral that finally, briefly ended.

"The question now is whether the impact of the new coronavirus is only temporary until the health crisis is over, or whether it will result in a prolonged economic downturn that will disrupt the scenario in which Japan escapes deflation," the SocGen duo say.

On Wednesday, Abe said the "bold stimulus package" will include "necessary and sufficient" measures to ensure Japan does not re-enter deflation. He didn't give further specifics but said Japan's airlines would get support.

'Barely holding the line'

Japan has resisted stringent crackdowns on movement, although it has severely limited the arrival of international travelers. It is introducing travel bans on another 49 nations, including the United States, as of Friday. Abe has called the coronavirus outbreak a "national crisis" and said the country is "barely holding the line" against the Covid-19 disease but so far has not called for nationwide controls or the closure of offices. Investors are bracing for the possibility that Tokyo could be locked down for a month.

Government schools were closed nationwide from March 2. Tokyo had been hoping to re-open some of them now that the new academic year has started on April 1. It appears likely they will remain shut all this month.

Only Korean shares, with the Kospi closing down 4.4%, and the Indian market, with the Sensex down 4.1% in afternoon trade, fared worse than the Japanese market on Wednesday. Australian stocks, which have often moved out of sync with other Asian markets, were up on the day, with the S&P/ASX 200 rising 3.6%. Energy and mining stocks led the Aussie gains after Chinese manufacturing data for March proved less dire than expected. The private Caixin/Markit Chinese Purchasing Managers' Index rose to 50.1 in March, up from a record low of 40.3. A reading of 50 makes the difference between a contracting and an expanding economy.

Most analysts had expected a contraction at 45.5. Still, the month-by-month reading only looks positive because the prior reading was the worst on record. Chinese shares, in the form of the CSI 300 index, treaded water after the figures were released, posting a loss of 0.3% at the close.

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